Studies show that intense board monitoring of management teams can have serious costs for companies

By Bertrand C. Liang, MD, PhD, MBA Posted on 29 August 2013

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The Author

[caption align="alignleft" width="185"]Bertrand C. Liang, MD, PhD, MBA[/caption]Dr. Bertrand Liang is Visiting University Professor at Liaoning He University in Shenyang, China; Guest Lecturer in Biotechnology Strategy at the Rady School of Management at the University of California, San Diego; founder and Managing Director of LCC Ventures; and co-founder and Managing Director of Forward Medical Science Ventures. He also serves as CEO of Pfenex Inc., which was awarded a Fierce 15 designation in 2011 and the Frost & Sullivan Enabling Technology of the Year in North America in 2012.

Previously, he led a number of other companies, including Tracon Pharmaceuticals and Coronado Biosciences (NASDAQ: CNDO) and started 10 companies in the biotechnology arena. He has also held leadership roles in product development and corporate venture capital.

Dr. Liang holds a doctorate in medicine with clinical training in neurology and oncology; a PhD in molecular biology and genetics; and an MBA with advanced training in management, innovation and technology.

The function of boards of directors has clearly been influenced by the scandals that have occurred around lax oversight and perceived promulgation of management miscues, particularly in the 1990s. Responses have included regulatory statutes such as the Sarbanes-Oxley Act and various company directives. These have served to create transparency for stakeholders and a fundamental understanding of the true state of operations, as boards work with auditors and management teams.

However, with such a focus on monitoring the financial and operational components of the firm, with boards acting as a sentry of management teams, what is the cost to the company in terms of opportunity? Are there ramifications for board engagement as such, and has the overall outcome improved with such focus?

Fundamentally, has the creation of value, manifest by opportunities and innovation, been improved with such changes in oversight? Two recent articles in the MIT Sloan Management Review provide insight into the potential effects of the "sentry board" approach.

The trouble with too much board oversight

In the first article ("The Trouble with Too Much Board Oversight," MIT Sloan Management Review, Spring 2013), Dr. Olubunmi Faleye and colleagues note that there are benefits of oversight from the board. In particular, based on the tenet that board oversight ensures the management teams manage the company with appropriate fiduciary responsiveness for shareholders, sentry boards tend to achieve this objective.

With intense monitoring, defined as a majority of independent directors served on monitoring committees (e.g., audit and compensation), there was more likelihood of boards compensating CEOs appropriately, dismissing underperforming CEOs, and providing transparent and accurate reported earnings.

Of course, this level of oversight requires a significant effort in time and resources.Indeed, if this were the only function of a board of directors, there would be no need to further study the area. However, the role of a board has more paramount responsibilities that involve participation in strategy formation and assisting the management team to create value. The authors cite the 2010 NY Stock Exchange Corporate Governance Commission report, noting that value creation is the leading principle of corporate governance. In addition to being "distracting," monitoring and oversight creates significant opportunity costs to strategic advising and discussion.

Meanwhile, such sentry boards create conflictual relationships between the management team and the board, with negative results; indeed, several recent studies have noted less strategic interface and discussion about strategic issues within the milieu of intense monitoring.

Moreover, there is evidence to suggest that innovation suffers; in fact, boards more focused on oversight were found to have poorer performance, innovative capacity and value generation, compared to those where strategic advising with an eye to a longer-term strategy was noted.

The authors suggest that changing the board composition to create board structures that balance oversight and emphasize strategic advising is the most effective approach, ultimately meeting the directive of any board and management team — the maximization of value for all stakeholders.

Bringing opportunity oversight onto the board's agenda

In the second article ("Bringing Opportunity Oversight onto the Board's Agenda," MIT Sloan Management Review, Spring 2013), Larry Bennigson and Frank S. Leonard address the issue of boards concentrating on "watchdog" functions rather than value creation. The authors here note that the board's function really should revolve around value – both the maintenance of existing value and the creation of new value.

Their research suggests that boards spend far too much effort on risk-management oversight and far too little time on creation of value; there should be an emphasis of the board working together with the management team to generate a capability on opportunities, which has ramifications for competitiveness and growth. Indeed, being able to see important trends and market shifts early and responding to such shifts should be a manifestation of the "opportunity-aware" organizational culture and supported strongly by the board.

The authors note that there is oversight imbalance with respect to the high-level of emphasis on protecting existing value, and many boards do not have individuals with the expertise and experience necessary for an understanding of opportunity oversight. Indeed, the CEO is often tasked with such responsibilities, and like building out a management team or other capabilities, is integral to the building of the opportunity-aware firm. A true partnership between the board and the senior management team is required to develop this resource capability, with the board understanding both this concept and how a company achieves and maintains value and value-creation abilities.

While there are a number of ways to execute on such resource building for opportunity-generating capability (whether intrapreneurship, acquisition or active imagining for the future and building toward that vision), there are also clear examples where concentration on current value mechanisms, resistance toward new opportunities, and stagnant mindsets create risk aversion as well as destruction of value – both in value maintenance and value creation.

As noted by the authors, risk management and tacit conservatism is an at best a difficult pathway to competitive growth (and at worst a waste of resources at every level).

Conclusion

[pullquote align="right"]As noted by both studies, impotent strategies and boards — and board members with near-term torpid perspectives — create huge opportunity costs for companies and their futures.[/pullquote]Both these articles note the dichotomy between intense board oversight and the generation of a culture of innovation and growth — and the required balance between them.

What is so striking is the independent conclusions of both studies: that the focus on strategy and cooperation between boards and management teams is key to deliver on stakeholder value, whether this is with respect to innovation or opportunity generation.

These are important findings that apply to all types of firms, whether large or small, private or public, to cultivate the appropriate value-generating capabilities. Moreover, having the suitable mindset, and ultimately people, whether on the board or the management team, is critical to fulfilling the potential for organizational excellence. As noted by both studies, impotent strategies and boards — and board members with near-term torpid perspectives — create huge opportunity costs for companies and their futures.